Quote:
Originally Posted by opendoor
You're talking like companies raise their own stock price unilaterally, but it's investors (who base their valuation on things like debt) who determine the price. In an efficient market, the market cap will tend to be total company value minus debt and preferred shareholder value. So a $500B market cap company with no debt is being valued similarly by the market to a $200B market cap company which has $300B in debt. But the first company will have a P/E that's 2.5x that of the second company at a given net income level, which is why P/E on its own isn't a particularly useful metric.
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No, I am not suggesting that a company can raise their own stock price. I am saying that your argument is circular: if you use market cap when comparing debt levels, then a higher market cap improves the debt ratio which, in your argument, would make the company more attractive, justifying a higher price, and thus a still-higher market cap. Circular.
Market cap and P/E are both direct functions of price. If price goes up (all else held constant), market cap and P/E both go up. Claiming the market cap justifies the P/E is simply saying that the price justifies the price, and a higher price justifies an even higher price.
You said 'at a given net income level', I assume you mean a given net income level
per share (otherwise we have apples and oranges). With the same income per share, the companies should be worth the same, assuming the same growth expectations. The fact that one has more debt only means that they have to have higher revenues in order to cover the debt service and thus have the same net income. The only reason to value one higher than the other, based on the debt level, is that you think the debt level will impact earnings in some way (good or bad). You can't simply say that the first company's equity should equal the second company's equity plus their debt ($500b = $200B + $300B). Their equity should be equal, plus or minus the expected impact of the debt on company B.
Essentially you are using the market cap to determine the value ($500B vs $200B). But value is not a function of market cap, market cap is a function of value. Let's run another quick example:
Two companies start with nothing, and each raise $200B in an IPO, issuing 20B shares at $10. They each now have $200B in equity (and a market cap of $200B). Both generate net income of $1/share, and both have similar growth expectations, and at $10 per share, they each have a P/E of 10X. Now company B raises $300B in debt. Should company A suddenly be worth $500B, simply because company B now has the $300B in debt? No. They are still equal companies.
Company valuation is about earnings. And growth of those earnings. The amount of debt that a company has, is a contributing factor in determining the value of the company - of course. However, it is not a direct, 1 to 1 factor, and less debt is not an automatic positive for the company (as PeteMoss outlined a few posts ago). Tesla's P/E is a function of investors' optimism about earnings growth. And based on the fact that Tesla's head start, and market advantage, are now largely gone, or at least rapidly deteriorating, I think the P/E is too high.